Ronald Coase: Business is a Math Problem

Lately I’ve been thinking and writing about the economic theorists and thought leaders who set the stage for modern outsourcing to really take off. For me, the obvious choice to begin this mini-series of posts is with Ronald Coase, who was a pioneer in the area of transaction costs and the nature of the firm.

Coase’s groundbreaking work around the institutional structures and practices of companies began in the 1930s. In simple terms, Coase said that it was not enough to concentrate only on production and transportation as the main costs of doing business. Rather, the University of Chicago professor asserted that businesses needed to also consider the cost of entering into and executing contracts. His viewpoints came to be commonly be referred to as transaction costs.

Today’s companies expend a considerable portion of their total resources on transaction costs. When all transaction costs are part of the mix of doing business, it turns out that the existence of firms, differing corporate forms, variations in contract arrangements, and even the structure of the financial and legal system can be given relatively simple explanations, according to Coase and a long line of Chicago School economists. By incorporating the different types of transaction costs, Coase paved the way for a systematic analysis of economic institutions.